Responsible Investing seeks to both align investments with values and obtain attractive returns. While studies found little consistent predictive power from commercially-available screens of companies based on environmental, social and corporate governance (ESG) ratings, increasingly the historical perception that Responsible Investing investment products deliver subpar performance is diminishing. Given the large and growing demand of Responsible Investing mandates along with the challenges in the existing offerings, there is significant room for innovation to introduce products that provide both better alignment with values and better prospects for attractive returns.
For instance regarding global investing, countries can play a large role in improving the quality of company ratings against Responsible Investing criteria. This role includes strengthening and broadening the information reported by corporations, while also assuring common definition of the reported information. A United Nations report specifically identifies a stronger role for governments in requiring companies to report more information.
Country research may be the next major improvement to Responsible Investing.
In particular, corporate governance is significantly impacted by the requirements of the countries under which they are regulated. If two companies in different countries receive the same ESG score from a commercial provider of such ratings, the country can be the deciding factor regarding which company is a better investment. The company in the country with the better reporting requirements and where Responsible Investing is more important is more likely to make further improvements to its ESG score. Since active management of a Responsible Investing portfolio is already identified as a best practice to produce better returns, then the selection of a company based on its country is a way to actively manage a portfolio based on where the greatest improvement is most likely.
Researching country-level information has traditionally encountered significant challenges. The available information is mostly not standardized and is inherently qualitative. Non-governmental organizations can be helpful as they perform substantial research on countries, including economic statistics (e.g., GDP, GDP per capita, trade balances) and social welfare (e.g., child labor, environmental quality). While such research is important and has many uses, it does not provide what the investment community needs. Researchers need to place the available facts into frameworks yielding clear overall pictures so that analysts can compare countries on an “apples to apples” basis. This is not easily accomplished; if it were easy, analysts would already have access to such information.
Sustainable Wealth Creation principles may be measured
Magni has developed a process for researching and assessing the investible countries of the world using its Sustainable Wealth Creation principles. Sustainable Wealth Creation principles are based on well-accepted economic principles. Twelve Economic Standards and roughly 270 Qualitative Sovereign Factors are used to score countries on the quality of their economic infrastructure. Collectively the Economic Standards measure the quality of the country’s economic infrastructure, including honesty, inclusiveness, transparency, and include:
(1) Government fiscal and monetary policies that are open, stable, and clearly communicated so that citizens and businesses can make sound decisions;
(2) A legal and regulatory environment that is equitable to all participants, and stable so that citizens and business feel their rights and property are protected;
(3) Financial and related systems that allow money and goods to be exchanged openly, honestly, and efficiently; and
(4) Accounting and auditing requirements so that financial statements from businesses accurately reflect actual performance.
Countries who receive high scores according to the Sustainable Wealth Creation principles are required to have more than strong intent and/or rules; there must be evidence that the companies within the country adopt the intended behavior. Further, high-scoring countries also have healthy economic infrastructures where investors are more likely to consider Responsible Investing important, thus creating demand for continued improvement by the companies within the country.
In essence, Countries Matter™ when building an ESG or SRI investment portfolio.
Looking for more perspective on sustainable investing? Download our whitepaper: “Country Selection – An Important Addition to Responsible Investing.” Follow Magni Global Asset Management on LinkedIn and Twitter @MagniGlobal, #CountriesMatter.